It's that time of the year again when we reflect on what we got right and wrong. At the start of 2017 we figured the US Federal Reserve would hike rates three or four times, which was more aggressive than the consensus. The market is placing a near-100 per cent probability of a third hike this month.

We also thought there was a slightly better than 50 per cent chance the RBA would be forced by a booming housing market into at least one 'financial stability' hike. APRA and the banks instead obliged.

That was enough to break the back of the five-year-long housing boom first triggered by the RBA slashing interest rates in 2012 and 2013. We declared in late April 2017 that the great Aussie housing boom was over, and were a few months early.

Sydney prices started rolling over in August and have recorded cumulative losses of 1.5 per cent since the end of July based on the CoreLogic indices. Across the five largest cities, prices started slowly deflating in October and have shaved a modest 0.2 per cent off the largest source of household wealth since September.

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This is one reason why we have not invested in securitised pools of home loans originated after 2015 – assets sourced before this benefit from the credit enhancement delivered by the big boom and should not be impacted by any correction. (On a relative value basis, though, AAA rated residential mortgage-backed securities are still cheap.)

A few rate hikes next year

We expect the RBA to lift rates a couple of times next year as it is "surprised" by an unemployment rate that is far lower than its end-2018 forecast of 5.5 per cent (it's already 5.4 per cent and it should comfortably punch through 5 per cent, which is the RBA's "full-employment" estimate, in 2018).

As we move into 2019 this should solidify a gradual residential property correction, which while potentially precipitating some hysteria, represents a much-needed and orderly recalibration of valuations.

Contrary to silly bank economist claims that house prices can only fall if the unemployment rate climbs, we have for years argued that bids and offers in any market are determined by expectations, which means valuations can shrink while the unemployment rate is declining. That's happening right now.

Australia is indeed the lucky country: we get to deflate the mother of all bubbles at a time when the jobless rate has dropped from 6.4 per cent to 5.4 per cent as the economy expands briskly (real GDP printed this week at a healthy 2.8 per cent annual pace).

And I put my money where my mouth is: after buying a property in November last year, I sold it this week to lock in the 56 per cent gross capital gain. (It's actually still cheap and the new owner will ultimately make a small fortune redeveloping it.)

A key forecast for several years has been that the unemployment rate in the world's largest economy would fall well below the Fed's estimates of full-employment at about 4.5 per cent. In 2017 the US jobless rate has declined from 4.7 per cent to 4.1 per cent. We projected that it would contract below 4 per cent by the end of 2017 or early 2018, and it is tracking to that goal.

Contrarian case

While wage and inflation pressures in the US spiked over 2015 and 2016, this year has not met our expectations of a further pick-up.

It appears that a handful of random downside surprises coincided to undermine core inflation. This should mean-revert and we remain confident that neither wages growth nor inflation have been killed off by debt or technological disruption, as many claim. Our contrarian case sees core inflation in the US surprising on the high side, punching through the Fed's 2 per cent target and forcing a sharper re-rating of long-term interest rates.

We've been sanguine on local and global economic growth, and the world has not disappointed with seemingly never-ending positive data surprises out of the US, the UK and Europe. (The IMF recently upgraded its global growth forecast to 3.8 per cent in 2018.)

At the start of 2017 we said that Australian credit spreads, which represent the risk premium above government bond yields that companies pay to borrow money, would gradually grind tighter, which has been the story of the year.

While investment-grade corporate spreads in the US are at, or inside, pre-crisis levels, Australian financial and corporate risk premia are much more attractive. RBA data highlights that A rated (BBB rated) corporate spreads are 2.4 times (1.8 times) higher than they were in December 2006. Aussie financial spreads are 5 to 10 times wider relative to pre-crisis troughs.

In early 2017 we argued Standard & Poor's would have no grounds to downgrade Australia's AAA rating nor increase the country's economic risk score given our view that the housing boom would cool and that the budget would be more parsimonious than agencies thought. S&P duly backed off the rating after a prudent budget coupled with superior economic data, and has been vindicated by substantial upside surprises in the budget performance since.

Less debt funding

But the rating agency did push up Australia's economic risk score, which downgraded the credit ratings of non-major banks. S&P pulled this trigger well in advance of the timetable it gave the regulator. The outright declines in house prices since July call into question this decision.

For years we've maintained that the major banks would have to grow their core common equity tier 1 capital ratios with up to $40 billion in extra cash needed in what would be the biggest deleveraging of their balance sheets in modern history.

By 2020 APRA's new "unquestionably strong" capital ratio of "at least 10.5 per cent" will have compelled $40 billion of capital accumulation since the banks' non-risk-weighted nadir in June 2014. Combined with slow balance-sheet growth, this has meant that the majors require less debt funding, which has satisfied another key forecast: lower than expected domestic bond issuance that would create favourable scarcity technicals for investors holding these assets (we do).

Major bank issuance in 2017 has been 26 per cent less than the volume printed in 2016. The de-risking of their businesses through much more first-loss equity, widespread asset sales of non-core activities (eg, life and wealth units), and withdrawals from overseas markets (Asia and the UK) is also credit positive for their Additional Tier 1 (AT1) hybrid instruments, which we've been bullish on this year.

The big banks' five-year AT1 spreads have compressed from close to 400 basis points over bank bills in early 2017 to around 300 basis points in recent months (providing solid capital gains), although there has been some contemporary choppiness as a result of three new regional issues. We see this as a buying opportunity given our fair value estimate, which is sub 250 basis points.

Another long-term central case has been the belief that Asian geopolitical risks would escalate, fuelled by tension between North Korea and China, on the one hand, and the US and their near-neighbours on the other. This is why we refuse to buy companies issuing bonds out of non-democratic states, or proximate nations like Japan and South Korea.

Finally, we were vocal proponents of the reflationary Trump trade from the moment he was elected and, despite some big bumps along the way, Donald is delivering.

The author is a portfolio manager with Coolabah Capital Investments, which invests in fixed-income securities including those discussed by this column.